Concepts/ Definitions related to the first chapter.

Engineering Economy Study: an evaluation and comparison of alternatives in which

differences among those alternatives are expressed as monetary values. Usually involves a
decision -making process with these steps:
1. Recognition and formulation of the problem
2. Search for feasible alternatives
3. Quantification and analysis of alternatives
4. Selection of the best alternatives. (least cost)

Time Value of Money: It is a fact that money makes money. This concept explains the
change in the amount of money over time for both owned and borrowed funds.
Economic Equivalence:
To compare alternatiee that proiide the eame eeriice oier extended periode of tme when intereet
ie iniolied, we muet reduce them to an equiialent baeie, Equiialence factore are needed in
engineering economy to make caeh fowe (F) at diferent pointe in tme comparable. For example, a
caeh payment that hae to be made today cannot be compared directly to a caeh payment that muet
be made by the end of 5 yeare. So, A combination of time value of money and interest rate that
makes different sums of money at different times have equal economic value is called
economic equiialence.

Cash Flow: The flow of money into and out of a company, project, or activity. Revenues are
cash
inflows and carry a positive (+) sign; expenses are outflows and carry a negative (−) sign. If
only costs are involved, the − sign may be omitted, e.g., benefit t/cost (B/C) analysis.
Cash flows describe income and outflow of money over time
Disbursements =outflows “-”
Receipts =inflows “+”
Beginning of first year is traditionally defined as “Time 0”

Inflation: expressed as a percentage per time (% per year), it is an increase in the amount of
money required to purchase the same amount of goods or services over time. Inflation occurs
when the value of a currency decreases. Economic evaluations are performed using either a
market (inflation-adjusted) interest rate or an inflation-free rate (constant-value terms).
Risk Variation from an expected, desirable, or predicted value that may be detrimental to the
product, process, or system. Risk represents an absence of or deviation from certainty.

1
Probability estimates of variation (values) help evaluate risk and uncertainty using statistics
and simulation
The interest i: Interest is usually expressed as a percentage of the amount owed
– It is due and payable at the close of each period of time involved in the agreed transaction
(usually every year or month).
The Interest Rate: Called also the rate of capital growth, it is the rate of gain received from
an investment.
– It is expressed on an annual basis.
– For the lender, it consists, for convenience, of (1) risk of loss, (2) administrative expenses,
and (3) profit or pure gain.
– For the borrower, it is the cost of using a capital for immediately meeting his or her needs
Compound interest: the interest calculation procedure which require interest to be earned –
charged against the interest already earned as well as the principal. As opposed to simple
interest. Which doesn’t compute interest on interest.